Category Archives: Pension

Early Retirement: Distributions Without Penalty Before Age 59½

Posted on by
Reply

If you are considering retiring early and would like to use your pre-tax retirement accounts before age 59½ then you have significant planning to ensure you make the most of your retirement assets. One possibility is to use a 72(t) exception to avoid the early withdrawal penalty from pre-tax accounts. This 10% penalty is in addition to ordinary income tax.

An exception to the 10% penalty is the 72(t)(2)(A)(iv) OR “a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the employee or the joint lives (or joint life expectancies) of such employee and his designated beneficiary”. This exception allows for regular payments from pre-tax accounts but must be tailored to your specific situation.

In general, the 72(t) exception requires that a calculated payment be withdrawn from a pre-tax account annually for the longer of five years or at age 59½. The advantage is that the 10% penalty can be avoided but the disadvantage is that changes to withdrawals or distributions are NOT permitted, or penalties apply. When calculating the annual payment, we consider the age of the pre-tax account owner, the balance in the pre-tax account, and the current interest rate. Higher payments are obtained at later ages, with higher account balances and at higher interest rates.

To help you visualize how the 72(t) amortization works, the table below shows annual payments for a single person at different ages on an account with $100K in pre-tax savings given that the current interest rate is at 6.16%.

Those thinking to retire early should consider using pre-tax assets (with the 72(t) exception) to support their planned cash flow but only if it is the best way to deploy all available assets. When using the 72(t)-exception you need to understand the implications of the rules since large penalties apply for errors or misunderstandings. If you are considering retiring early, we would determine how to best deploy your assets throughout your retirement plan.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Guidance on inherited IRA RMD – IRS Notice 2023-54

Posted on by
Reply

The original SECURE Act, signed into law in December 2019, changed many of the long-standing rules governing IRAs and other retirement accounts, and no single measure in the legislation had a more seismic impact on retirement planning. Specifically, the law stipulated that “Non-Eligible Designated Beneficiaries” (i.e., neither surviving spouses or disabled/minor beneficiary) would be required to empty the inherited retirement account by the end of the 10th year after the decedent’s death (and would no longer be able to ‘stretch’ the distributions over their own life expectancy).

While we expected that Non-Eligible Designated Beneficiaries would not be required to take annual distributions in addition to emptying their accounts in the 10-year period, the IRS in February 2022 issued Proposed Regulations that would make a subset of these beneficiaries subject to BOTH the 10-Year Rule and annual Required Minimum Distributions (RMDs). The caveat, however, was that these were merely proposed regulations.

In October 2022 we were informed that there wouldn’t be a penalty if beneficiaries didn’t take a 2022 RMD but by October most had already! Unfortunately, they failed to address the requirements for 2023 and onward.

Finally, this month the IRS released Notice 2023-54, which provides relief once again by eliminating any penalties for failing to take (potential) RMDs for 2023 for these specific beneficiaries. Once again, they punted the RMD decision another year (2024). Keep in mind that these beneficiaries MUST still empty the IRA account by the 10th year.

Although we monitor notices on RMD rules changes and discuss RMD requirements with each of you as needed each year, your engagement in this topic ensures that we understand the relevant regulations for your financial plan.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Inherited IRA Beneficiary Rule – A brief overview

Posted on by
Reply

An inherited IRA from a loved one used to be a gift to beneficiaries that was easy to implement with little tax impact and a lifetime of reward. In the last four years, the rules have changed dramatically and now inheriting an IRA can result in a surprisingly large tax liability. It now requires detailed understanding of the rules to ensure the correct ones are applied without additional tax liability.

Below are the rules and the process that we follow with inherited IRAs. We first separate beneficiaries into three large categories: (1) eligible designated beneficiary, or (2) a non-eligible designated beneficiary or (3) a non-designated beneficiary.

Once we know the type of beneficiary we can drill down and verify by using decedent details (below is a chart for non-spousal beneficiaries).

Why is this important? Because the amount of tax liability is at much higher rates if the withdrawals are forced in 5 rather than in 10 years or over your lifetime. In addition, the custodian needs to be encouraged and educated on the nuances of the applicable rules to your situation so that they don’t choose to use the default 5-year worst case scenario. Sometimes we’ve needed to use legal advice to ensure that the correct beneficiary distribution is implemented by the custodian particularly when the beneficiary is a trust.

The take home message is to make sure beneficiaries are clearly delineated in the IRA account form and that inherited IRA transfers follow the correct inherited IRA beneficiary rules.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

SECURE Act 2.0

Posted on by
Reply

The first “Setting Every Community Up for Retirement Enhancement” Act (SECURE Act) was passed December 2019 eliminating the ‘stretch IRA’ for non-spouse and changing the RMD (Required Minimum Distribution) age to 72. These were changes that impacted everyone across the board. With the Secure Act 2.0, congress appears to be reversing its prior leanings and instead allowing Roth conversions. The reversal towards ‘Rothification’ (encouraging ROTH savings/conversions) appears to be with the goal of increasing tax revenues today. It is fair to say that no single provision made by the SECURE Act 2.0 appears to have the same impact across so many as the elimination of the stretch, which now requires many inherited distributions to complete within 10 years, rather than spreading distributions over the entire beneficiary’s lifetime. Even so, 2.0 has so many more detailed provisions that it will impact most in some way. It is already evident that implementation will take more effort than the first SECURE Act.

Some of the new provisions included in SECURE Act 2.0 will be implemented over the next two years and require preparation in 2023. We will explore the provisions that may be relevant to your specific situation during our meetings this year. Let us know if you have any questions.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

How does a tax-deferred IRA differ from a Roth?

Posted on by
Reply

Tax-deferred savings (to an IRA or employer pre-tax retirement plan) reduce your tax liability today BUT are fully taxable (including gains) on withdrawal. The tax-deferral accounts are an excellent way to minimize your current taxable income. The goal is to use what would have been tax dollars as part of your savings. The main rules to keep in mind are that withdrawals shouldn’t be expected before age 59.5 AND that you MUST take mandated distributions (called RMD) when you reach age 72 (according to the new tax rules). Unfortunately, these accounts are now also not inherited in the same beneficial manner as in the past (these now follow the new Secure Act of 2019 rules).

A Roth on the other hand, doesn’t provide tax deferral when saved but it does provide tax-free dollars, on withdrawal. Contributions to a Roth are limited in amounts each year and not easily available for high earners. Whereas Roth conversions require income tax payment on converting pre-tax IRA dollars, not everyone is permitted to make Roth conversions. Fortunately, Roth IRAs are not impacted by the Secure Act of 2019 and remain free of RMD. They are also still inherited tax-free to individual or trust beneficiaries and are likely to be favored for those considering leaving a legacy.

As income tax rises (likely, given our debt load), Roth accounts will become even more powerful tools in retirement for those in the higher tax brackets. Currently they help us regulate your taxable income and keep taxes and Medicare costs reasonable during retirement.

We’d like to consider Roth conversions for you in years when you expect a lower tax rate. It is particularly useful when tax-deferred accounts are undervalued and when you have accumulated large tax-deferred accounts.

The basic takeaway is that a tax-deferred account should be maximized during years with high earnings (to reduce taxes) and high tax rates. When you expect a low earning year then a Roth conversion may provide you with an ideal situation BUT ONLY IF your retirement tax rate is expected to be high enough to trigger additional taxes or Medicare costs.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

New tax rules (Secure Act of 2019)

Posted on by
Reply

As you know, we believe strongly that managing tax liability is essential to building wealth. The Secure Act of 2019 has made significant changes which we will use to create and action strategies best suited for each of you.
Everyone, near retirement, is aware that there was an extension to the Required Minimum Distribution (i.e., RMD) from age 70.5 to age 72. This is good for many since it gives you more control over your tax liability early in retirement, but it also has made the Roth accounts an even more powerful tool for some.

Sadly, the Secure Act of 2019 has made inherited IRAs a big tax burden for beneficiaries, particularly trust beneficiaries. Because of this, IRA accounts that use a trust as a beneficiary may need to be re-examined to ensure that the language allows beneficiaries to minimize their tax liability.
Let me know if these topics are of interest and we’ll include them at our next financial planning meeting.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

The skateboard champion and other stories

Posted on by
Reply

As a way to put money away and save on taxes we often think of retirement accounts for the self-employed that include a simplified employee pension plan (SEP), an individual 401K-profit sharing plan (401K-PSP), or Defined Benefit (DB) plan. DB plans are the least used and yet the most powerful at reducing tax liability and quickly increasing your tax-deferred savings. To illustrate how DB plans can be used, I want to share with you how creative individuals were able to leverage their DB plan to save maximally and retire early.

  • The Skateboard Champion – A 30-year-old skateboarder plans ahead and saves $130K per year from winnings and endorsements. He will have saved $2.6M by the time he turns 50 (without considering any market growth).
  • The Lobster Fisherman – A 61-year-old fisherman from Maine pays himself $35K in payroll from his C Corporation and saves $60K per year for the last five years before retiring. His reward: an estimated $300K in accumulated additional savings for his retirement.
  • The Clothing Store Sales Rep – At 57 years of age the rep contributes $150K per year for herself and $12K for her young assistant until retirement at age 65. She accumulates another $1.2M not including growth.
  • The Lobbyist from Virginia – Beginning at age 48, the lobbyist contributes $145K/year for 7 years saving just over $1M by age 55.
  • The University Professor & Guest Speaker – Starting at age 54, the Prof contributes $42K per year from guest speaking engagements. He does this for 12 years and adds $502K in savings (excluding growth) to his already substantial university benefit plans.

DB plans provide the highest contribution amounts particularly when combined with a 401K. To take full advantage of this type of plan, a business must have sufficient profit and cash flow. DB plans, like a 401k, must be established in the same year and have specific requirements including annual tax filings. DB plans are not limited by the fixed maximum contribution found in SEP or 401K plans but instead are based on age, payroll and future benefit. This year, the maximum annual future benefit is up to $210K (this can amount to substantially more than a $210K contribution in any one year).

If you have a side business or are starting your own full time business consider the DB plan. Even though these are powerful, the best type of retirement savings plan for you is dependent on your business’ current and projected cash flow. As you can tell from the stories above, a well-designed DB Plan is not just for those over 50 or those with large earnings. It can be a very smart way to defer taxes today and provide for your lifestyle in the future.

Defined Benefit plans are not appropriate for everyone but I’ve seen them work for so many different people in unexpected situations that I thought I’d share some success stories with you.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Retirement Portfolio Distribution – vital considerations

Posted on by
Reply

Not sure when and how to start dipping into your hard-earned retirement funds? It’s a BIG consideration with BIG implications. How might you withdraw your money without worry that you’ll outlive your portfolio?

You could use a generic retirement distribution model that targets a 4% withdrawal from your portfolio (if portfolio is allocated at 60/40 equities/bonds). This generic model focuses on not outliving your assets and often leaves much to be desired in terms of maximizing how you distribute your portfolio efficiently. This is where a retirement distribution plan is absolutely vital since it will outline the amount that you need to meet your specific needs each year, the impact on taxes and on your ability to not outlive your portfolio (particularly important 5-10 years to retirement).

Many studies demonstrate that creating a portfolio withdrawal plan that more closely fits your needs in early retirement while providing for your wishes later in retirement leads to a successful retirement. Of course, retirement planning first requires that you’ve accumulated enough assets to support your lifestyle for the length of your potential retirement. It should also allow for unexpected obstacles and other goals.

You may find after discussions that your retirement of choice might be much different than a standard generic model. In some cases, it is in your best interests to keep working even part-time into your “retirement.” This is becoming more and more the case (so don’t feel alone if it comes to that) even if you have enough assets to support full retirement.

A recent study by T. Rowe Price revealed that 22% of recent retirees have rejoined the workforce at least part-time and of these 18% are earning as much as they were earning prior to retirement. Of course others have chosen to adjust their budgets to extend the life of their portfolio and are living on 67% of pre-retirement incomes rather than returning to employment. The study found that retirees are covering their early retirement expenses from the following sources: 18% from pension plans, 42% from social security and 17% from tax-advantaged accounts.

The latest methods for funding retirement are much more specific to your individual situation than a flat 4% withdrawal. When working together (5-6 years to retirement) we’ll formulate your distribution plan through retirement. This would include how your portfolio will be allowed to recover from any potential market decline and how it provides for your wishes during the 30-40 years in retirement. As retirement approaches (or whenever you make the request) we will outline the latest successful approaches to asset distribution for your situation – we want to be sure that you don’t unnecessarily skimp through early retirement or outlive your portfolio later in life.

A formal retirement distribution plan should include a review of alternative income streams, a financial breakdown of at least the first 3 years of retirement, an overall budget for those years, including expected distribution and social security. This is when the value of having different cash flow streams becomes obvious. Taxable accounts, tax free, pension/social security, annuities, and tax-deferred are the usual assets considered in all retirement distribution plans.

By setting the finances for the first years in retirement, you can plan for the potential of a market downturn and also the possibility of allocating more during the first 10 years of retirement if you so wish. Most often, families want to spend their first 10 years traveling or hosting family events as a way of enjoying their most active phase of retirement.

The most obvious danger of ad-hoc or unplanned withdrawals from a portfolio is that the account balance dwindles faster than any return can support. By funding non-budget needs, the portfolio may no longer be able to fund the necessary budget items that are important in that client’s lifetime. To succeed, this requires open communication with our clients, their trust in our work, and their discipline to rein-in non-budget expenses.

Retirement can last 30-40 years and can exhaust any portfolio without a distribution plan. Outside of retirement, your other goals may or may not need a separate distribution plan (we do one for college plans and home purchase too). Speak to your advisor if you are in any way uncertain about how or when to tap into any of your portfolio savings.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Dec 15th deadline: Kaiser Permanente Make-Up Payment

Posted on by
Reply

Your Kaiser Retirement: TPMG’s Physician Benefits and Compensation Plan 2 November Make-Up Payment Letter

December 15th is the due date for responding to this letter but the decision is usually reached in late October anticipating the November Plan 2 direct deposit.  This letter addresses an over funding that occurs for some Plan 2 deferred compensation participants.  Kaiser refunds this amount to you and gives you until December 15th to contribute up to this amount in additional Plan 3 contribution.

To help our clients make this annual decision we review their family tax profile, current retirement savings, family goals, family financial exposures, and available cash flow.

It is our experience that the majority our clients select to make a voluntary contribution to Plan 3 of at least some of their Plan 2 make-up payment.

Although this is true for most clients it is not always the right choice for all.  When cash flow is tight, there is low tax liability, or their retirement goal is fully funded we find that clients tend to choose to apply the Plan 2 make-up payment to other wealth building purpose.

If you would like to prepare for next year’s voluntary payment decision reach out to your Wealth Planner.  If you are working with a professional Wealth Planner they should understand your specific situation before they provide advice – only accept fiduciary advice.  Finally, give yourself enough time to evaluate your tradeoffs so that you prioritize and fund all of your family goals.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Fixed Annuities – apply them with care

Posted on by
Reply

Fixed Annuities
– A limited but essential role in some retirement plans

Fixed annuities represent a contract between an individual and an insurance company. Annuities provide a contractual way for an individual to guarantee that he or she receives income for life or for a set period of time. Other liquid financial products like equities, can pay dividends that can be used as retirement income the income is not guaranteed. A fixed annuity will guarantee an individual a stream of income as long as he or she lives or for a set number of years.

Sometimes you can start with Deferred Fixed Annuities

Like all annuities, except those that are immediate, deferred fixed annuities have two phases. The first phase is the accumulation phase. During this phase, which can be as short as a few years or as long as several decades, the annuity owner makes regular deposits into the account. These deposits are known as premiums.

All premiums contributed to a deferred annuity grow tax-deferred which means that the growth income received at retirement will be taxed as ordinary income.

When an annuity owner, who is known as the “annuitant”, decides to have distributions start, the annuity is “annuitized”. This is a critical process that converts it to an immediate annuity and you begin receiving payouts. The distributions can be paid monthly, quarterly or annually, depending on the preferences of the annuitant. An annuitant should think about his or her distribution schedule very carefully, because once it starts, it cannot be changed. An insurance company will also typically let the annuitant choose the length of time over which the distributions are paid. Guaranteed payments can be taken for life or for a specific number of years. This selection will affect the amount of each payment.  Life annuities are the only ones that will give the promised guarantee life long income.  Consider that life long income may not support your current lifestyle particularly in high inflationary periods.

Under current federal tax law, an annuity owner cannot begin taking payouts on a tax-deferred annuity prior to age 59 ½ without incurring a 10% penalty. Any tax-deferred annuity must begin in the year in which the annuitant turns age 70 ½.

What are Immediate Fixed Annuities?

An immediate fixed annuity is funded with a single premium. The premium is typically after-tax money paid as one lump sum. You can also set this up from a mandatory distributions taken on a qualified account. The distributions made by the life insurance company begin immediately, typically within 12 months of the start of the contract.

Immediate Fixed Annuities Pros and Cons

The return % paid on fixed annuity is always fixed. It could change year over year, but once it’s set for the year it will not change regardless of stock market fluctuations. This can be of great help to those on a tight retirement budget unless the market rises and therefore inflation rises. The advantage will be that you’ll know exactly the amount of each payment that will be made. While the rate paid on a fixed annuity could vary from year to year, most insurance companies will guarantee a rate of between 3% and 5%. It’s important to note, however, this guaranteed amount might not be enough to offset any cost of living increase. Inflation is a real and significant threat to retirement savings.  It is best to do immediate annuities when interest rates are high.

You could purchase a COLA (cost of living adjustment) rider that adjusts with inflation to retain some of your future purchasing power. The COLA rider is a costly component of  a fixed annuity contract, but it will increase the amount of money that is paid out each year. The amount should be enough to counteract measured inflationary pressures.  If you can afford the COLA you might consider it or consider leaving a portion of your assets in an equity portfolio so that it growth with the economy and provides a real inflation hedge.

For some, another risk factor associated with a fixed annuity is the premature death of the contract owner. If an annuitant dies before he or she has been repaid the amount he or she paid in premiums, the insurance company will keep the balance. To offset this, most insurance companies now give a guarantee of some sort on the premium.  For example, if the annuitant has an annuity worth $300,000 and dies after having only received $50,000 back, the beneficiary will receive the remaining $250,000. Or, the annuitant can choose an option called “period certain”. If he or she chooses a period of 20 years but dies during year 10, the beneficiary will receive payouts for the remaining 10 years.

I only consider premature death an important risk factor if you have beneficiaries or a legacy you want funded.  Even so, there are other ways to cover this risk factor than to purchase this type of rider – particularly if you still qualify for life insurance.

Who Should Buy Fixed Annuities?

Retired investors who need to guarantee income for life or for a set amount of time are often advised to consider a fixed annuity. Retirees who rely on equity dividends for most of their income may also want to consider a fixed immediate annuity. Dividends can provide substantial income but are not guaranteed. They can be cancelled by the company at any time should it need to conserve cash.

A retired investor may also fear that he or she will outlive the money he or she has saved. An immediate fixed annuity will also provide financial security. The payouts will be guaranteed for as long as the annuitant is alive, regardless of the amount of the premium. Even when the amount of the payouts exceeds the premium, the insurance company is obligated to make the payouts. For those in good health with few liquid assets, a fixed annuity could make a difference in their standard of living BUT they are extremely costly and impossible to exit gracefully if your situation changes.

A fixed annuity investor should always make sure he or she has enough cash for emergencies. As outlined earlier, an annuity contract cannot be cancelled except under the extreme circumstances. Once the contract is signed, the only way an investor can receive his or her money is through the payouts.

Consumers are strongly encouraged to purchase annuities only after a thorough analysis by a NON annuity sales financial professional.  This is a major investment that once signed can’t be undone – read the fine print and understand the nuances and their impact on your entire retirement before you sign.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com